The Strategic Outlook

Strategic Group · 4380 SW Macadam Ave, Suite 260  Portland, OR 97239 · (503) 222-9737   ·  www.InvestwithStrategic.com

Strategic Group’s e-update

 

It’s always difficult to forecast the future.  Unless you’re a weather person, people actually expect you to be right.  And, what’s more, they remember all the times you were wrong.  Not the best inducement for hazarding a guess about the economic outlook, but we had a discussion about 2010 and this is what we see for the coming year.

 

Politically, it’s an election year.  The entire house and 1/3 of the Senate is up for election.  Not surprisingly, a large amount of stimulus dollars is scheduled to be spent this year.  As with the “Cash for Clunkers” and the “Homebuyers Tax Credit” the affects on the market may be sharp and to some extent short-term.  The stimulus that appears to have the most long-term benefit, both to investors and utilities may be Smart-Grid improvements. 

 

Healthcare (if passed) is not scheduled to significantly alter health insurance coverage for years.  On the other hand, the tax law changes as a result of the legislation could have ripple affects in the market.  Tanning salons were targeted for a tax, but Botox and cosmetic surgery were not.  (Which begs the question:  How old is the average congressman?)  Taxes aside, with such a long-time horizon for the implementation of any healthcare programs, investing in this sector remains unchanged: look for good companies with good products and watch them closely.

 

The outlook for environmental law changes (specifically Cap-And-Trade) are not a big concern.  The Budget Deficit, Unemployment, Healthcare, and elections, should dampen the fervor for this program.  Energy independence is a long-way off, solar has high start-up costs and longer paybacks than most homeowners are willing to accept, and wind is very capital intensive.

 

Unemployment appears to be a more significant concern.  There doesn’t appear to be any significant change in the outlook even through the end of 2010.  The best estimate I’ve heard for 2010 is somewhere in the mid-9% range by year end.  Couple that with the on-going deleveraging of personal debt, and consumption probably will not be anywhere near the levels necessary to achieve the growth necessary to produce a significant number of jobs.  As a result, the market will probably see modest gains in 2010, but double-digit gains in stocks by year end may be aiming too high.

 

China also poses a problem.  The combination of a stimulus package that created excess capacity, government-urged lending from banks, weak global demand, and the “feel” of another bubble make this an area where extreme caution is advisable.  At present, none of our core holdings are in China.

 

Interest is discussed in more detail in the accompanying article, so I will forgo discussion of that topic here.  (Wait for cheering to die down.)

 

So what does all this mean? In general, we see 2010 as a slower-growth year with selective opportunities for gains.  We are cautiously optimistic that 2010 will allow some breathing room at least initially.  The end of 2010 and 2011 are of greater concern at this time. Most of the federal stimulus spending will be in 2010. This concerns us because most of the market growth today is being fueled by governments and or the consumer.

 

As people pay off their debt and banks start to lend again it is hoped the consumer will step back into the market filling the gap left by waning government spending. If this occurs and, businesses have cut enough in 2009 to produce profits and position themselves for a strong 2010, then 2010 should be strong. If not the end of the year could be in doubt. Additionally, inflation, the end of the Bush tax cuts, and commercial loan losses may change the financial outlook.  But whatever happens, we will continue to watch the investments daily.  We want to participate in the upturn, but remain vigilant of any change in direction.

What’s in Store for 2010?

A new start or more of the same...

The Coming Currency War

Happy New Year! Not trying to wish time away, but the last two years have been a period that I hope we never repeat, namely the world’s economic financial fiasco. Things are getting better, but we still have a long way to go. So given the fragility of the world’s economy, how are things going to play out for us over the next few years? What countries will benefit the most with the current recovery? What countries are in for, or have already had a serious ‘wake up call’?

 

With the last question, you thought of the United States didn’t you? And regardless of your political persuasion, I’ll bet you are concerned with some of the same things that I’m concerned about. Surely the national debt, social security, Medicare, the war(s) and other things come immediately to mind. But for us, what adjustments does Strategic need to make now to better position you for the challenges that our country will likely encounter in the coming year(s)?

 

You might have noticed that we have already made a number of changes in your portfolio over the past few weeks as a result of the ever-changing financial landscape. Given the amount of money our government has printed lately, there will be a point where investors will demand a higher premium on interest bearing assets (bonds) now that fear has subsided in the marketplace. We watch this daily and have noticed a change in the trend, thus we’ve acted accordingly. Specifically, we have reduced the duration (moved to shorter term securities) on your domestic interest bearing assets since interest rates are likely to continue their climb upwards. As rates go up, long term securities will go down a disproportionate amount in value since investors will demand higher rates. On the global front, we’re not as concerned about duration risk since interest rates are fairly stable as a whole. THIS WILL NOT HOLD TRUE FOREVER! We will make a similar move with your global bonds at the appropriate time!

 

So, given that rates are low and likely to climb, what does that mean for our other investments? If you’ve read a recent Federal Reserve’s FOMC meeting statement lately, you’re probably aware that our government is planning on keeping rates as low as they can for an extended period of time. I know, “Doesn’t that contradict what I said in the previous paragraph?” Let me answer the question by asking you a question. If you need to borrow money (like our government), would you prefer to pay a lower rate or a higher rate? The question answers itself now doesn’t it?

 

Our government is doing everything it can to keep rates as low as possible, and are counting on inflation and corresponding growth to inflate us out of this mess in years to come. Inflation is beneficial to our government and the economy as a whole, especially given the tepid (and fragile) recovery. This inflation will result in a stronger currency; big money (China’s government) doesn’t care since the United States will become the new “carry trade” country. The carry trade is when investors borrow at low rates and invest in something that has a higher rate of return, frequently another and stronger currency such as the Australian Dollar. This takes investment capital away from the “carry trade” country without producing benefits for the local economy and strengthens the “carry trade” currency. Japan is the current “carry trade” country with exceptionally low interest and one of the strongest currencies.

 

Now why wouldn’t a country want its currency to be strong? They may, but it’s all about balance! Folks that travel want their personal funds to have more purchasing power for obvious reasons. On the other hand, a country would prefer to have the right amount of exports, and this may mean having a weaker currency to influence buying activity. Assume that your company makes essentially the same product as a company from another country; we would probably buy the less expensive one, assuming everything else is equal. And this is what drives imports and exports to a large extent. The other side of the currency pendulum is inflation. If factories are operating at peak capacity, wage and price inflation soon follow. The Federal Reserve monitors economic data and does their best to keep a sense of balance by tweaking short-term interest rates.

 

This leads me to the topic at hand… since the world is pulling out of the “Great Global Recession”, every country wants the business activity, and thus a currency war is in the making! Right now, the U.S. has a competitive advantage because our currency is in the toilet meaning foreigners can buy more products for the money. Since our companies offer pretty good products and services for the price, there is demand, but it is lukewarm since other countries are having similar problems. Governments from around the world have responded by creating stimulus packages in an effort to encourage their own domestic growth. Surely it will work, but it will take time.

 

By keeping one’s currency low, it should accelerate the recovery. China has been reporting 8% plus growth for an extended period, although many economists question the validity of their numbers. Chinese rely on the rest of the world to buy their products, since their economy is less consumption based than ours, thus they have elected to keep their currency essentially pegged to the U.S. dollar despite our government’s recommendation to have them float their currency. Japan is eager to devalue the Yen since their economy has been in the slumps for decades and would benefit from a weaker currency. We all want Japanese goods but don’t want to pay the price! Euro denominated countries have their own set of challenges since they are unable to print more money like the U.S. Can you imagine the U.S. government working with Canada and Mexico to fix our situation? Believe it or not, there have been many discussions of moving North America to the Amero!

 

So in the end, the coming currency war is starting to unfold before our eyes since everyone wants to devalue their currency to encourage business activity; and right now the U.S. is kind of in the driver’s seat. China has played out their hand well, but it’s only a matter of time when they will have a similar set of challenges that we’ve faced over the last decade, especially once they begin to float their currency. Our currency will likely appreciate as a result of the carry trade not to mention that our dollar is still the world’s reserve currency. Currencies typically do not reverse course overnight… trends go on for years. And this trend is just getting started. If this plays out as I suspect it will over the next few years, it will create a new set of challenges to hedge currency risk, especially for novice investors. If the U.S. dollar stays low, this should be a net positive for our economy provided that our government doesn’t do something totally outlandish like Venezuelan President Hugo Chavez did last week (devalued the Bolívar currency by 50%).

 

No matter how the currency war unfolds, Strategic will position your portfolio to take advantage of the opportunities that present themselves no matter who eventually wins on a global scale.

 

We look forward to visiting with you in the coming year.